By Antony Gifford, a fund manager at Henderson Global Investors Global equity markets rallied st...
By Antony Gifford, a fund manager at Henderson Global Investors
Global equity markets rallied strongly in October, as better-than-expected corporate earnings, and perceptions that a military attack on Iraq was not imminent, encouraged investors to snap up attractively-valued shares.
Technology and telecommunications stocks, which had been heavily oversold, enjoyed some of the strongest gains. This was despite disappointing economic data across all regions, but particularly in the US, which rekindled concerns about the health of the global economy and raised expectations that central banks would cut interest rates before long.
Nevertheless, we continue to believe that US will spearhead a soggy global economic recovery. This is a fairly optimistic view relative to the market consensus, but we believe there are strong reasons to support it.
Consumer spending will be the linchpin of this recovery, and with mortgage refinancing soaring to record-high levels the prospects for this being maintained at healthy levels are good. So far, consumers appear to have primarily used their windfall gains to purchase new cars. This trend now appears to be tailing off but with the Christmas holiday season in sight, more money could flow into other goods and services.
Gloomy consumer sentiment surveys should not unduly panic investors because these have generally been poor indicators of actual spending habits. The full impact of this refinancing-linked spending on the economy may not be evident before March or April.
Against this backdrop, there are several other factors that should sustain the recent equity market rally. First, valuations between equities and bonds are currently at a twenty-year extreme: in other words, equities are even cheaper today than they were expensive during the technology bubble. Second, liquidity levels have improved significantly; and as confidence is restored, this should begin to flow into the equity market.
Third, levels of pessimism are sky-high: in July, retail investors withdrew a record US$50bn from mutual funds. Although this may be counter-intuitive, it usually points to a bottom in the market in fact, when the market re-tested its July lows in September, withdrawals were a relatively paltry US $12bn, despite even gloomier sentiment). Fourth, directors have become active buyers of their own companies' shares: and if the people who understand their businesses best believe that the market is undervaluing them, this provides a strong signal to other investors that there may be some attractive investment opportunities out there. Finally, third-quarter corporate earnings were generally better than expectations. With companies having already cut costs aggressively, any future top-line growth should filter through generously into earnings.
Some risks remain, of course. The biggest is faltering consumer spending (which could happen for reasons ranging from concerns about job security to further terrorist attacks) because the industrial sector is too weak to fuel growth ' in that case, the US ' and thus global ' economy would sink into recession. Extraordinary events aside, we are confident that this is unlikely to happen.
Soggy US economic recovery is on track.
Valuations are at attractive levels.
Corporate earnings are improving.
Global growth is fully dependent on the US.
US consumer is the linchpin of US growth.
War on Iraq or further terrorist attacks.
Less environment, more governance threatens to undermine firms' green credentials
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